Chapter 7. The Entrepreneurial Organization: Sharing Your Vision with Others

Entrepreneurial leadership poses special challenges. Entrepreneurs are in a unique situation—they are generally alone. The entrepreneur may have investors or advisors, but in the end the entrepreneur is the decision maker, and often decisions need to be made quickly, making it possible for entrepreneurs to execute rapidly. That is why entrepreneurial environments provide fertile ground for leadership.

Although entrepreneurship might not at first appear to be a context in its own right—like academia or a professional services organization—starting or leading an entrepreneurial venture has its own unique challenges. Building an organization as an entrepreneur calls for specific leadership skills—including the ability to identify the right business opportunities, finding ways to judge the right level of resources that should be invested to turn the opportunity into a profitable investment, and finding the right CEO and leadership team to make that happen.

In this chapter, I describe how leadership in this context works differently than in other contexts I explore in the book. Most of the chapter is about my experience as an entrepreneur after I left the deanship at the Wharton School in 1990. I share with you the hard-won lessons that I learned that can increase your chances for success as an entrepreneurial leader.

First I explain how I came to be an entrepreneur. The rest of the chapter is in reverse chronological order. I describe the entrepreneurial ventures that went well from the beginning, though they were not the first that I and my partners embarked on. My intention is to tell you how a well-planned and -researched venture should be led. Then, in keeping with my format of these context chapters, I tell you about the pitfalls you face as an entrepreneurial leader and describe the near disasters that I faced when I first began. In the last section of this chapter, I warn you about leading in a different context—the one that you will find yourself in if your venture is successful.

One final point. This chapter is about an entrepreneur whose motivation was simply to become an entrepreneur. I knew which business I wanted to enter: I wanted to invest in companies that my colleagues and I could build into valuable enterprises—even though I wasn’t certain in which industries these companies might be. In that sense my experience differed from that of someone who might venture into an entrepreneurial career without knowing what business to enter, or someone who had an idea for a particular business, or who had an invention to commercialize. Nevertheless, I believe that my experiences would be similar to those of other entrepreneurs no matter what their intentions may be.

Context: The Entrepreneurial Organization

The challenge the entrepreneurial leader faces is knitting together the investors, advisors, customers, and vendors with his or her vision. That is a matter of negotiation. It is the price entrepreneurs must pay for the fact that, though they might be alone in making decisions, they must operate within a business framework to succeed.

To ground this chapter in the real world, I describe my experience after I left the Wharton School.

Life After Wharton

About a year before the end of my seven-year term as dean, I decided it was time to leave Wharton. The faculty offered me a second term, but I firmly believe—as I have stated elsewhere—that no one should be in the same job too long. So I decided that it was time to move on. I sat back and thought for a few months about what I might do. I concluded that I probably had one more full-time career left in me, and I said to myself, “I should try to make this the best one yet—last and best.”

I thought a lot about what I wanted to do and finally ended up with three bullet points on a piece of paper that were most important in terms of defining this phase of my career:

• Have fun and do something meaningful.

• Do something of excellence that I could be proud of.

• Be successful and make some money.

These three points were written in order of importance. To have fun and do something meaningful was paramount. Then I asked myself what would fit into that category. I decided I did not want to head something that was in effect someone else’s business. I also did not want to get into the nonprofit world, because through my dealings with such organizations I had learned that with all their committees and boards, they moved much too slowly for me. I surely did not want to go into politics. Finally I concluded that I needed to set up my own business, to become an entrepreneur. This would give me the flexibility to do what I wanted.

I set up The Palmer Group with offices two blocks from the University of Pennsylvania, and I wasn’t exactly sure what I was going to do except that it would certainly be in keeping with the three criteria I had set up. A lot of people suggested that I raise a fund to buy out companies. I definitely did not want to do that. Imagine going to investors to try and raise funding, and when they asked what I intended to do with the money, having to say that my primary goal was “to have fun and do something meaningful.” Apart from being a hard sell and not exactly appealing from a business standpoint, it might make investors wonder if I was being serious. No, that wouldn’t work. So I decided I would just do this on my own, whatever “this” was. In the end I decided that we would buy small companies, build them up, and probably exit some day, but not in a typical venture capital format. I didn’t like the thought of buying a company, building it up, and flipping it. I preferred the approach of acquiring a business, building it up, and looking at it as if we would own it forever, even though some day we might exit.

Our initial venture nearly sank us, and I will describe it and other early experiences later as object lessons on the pitfalls that lie in store for would-be entrepreneurs. As we gained experience, we found a business that held great potential for us: professional schools. It wasn’t the only business we entered, but it is a good example of the kind of entrepreneurial leadership that works.

I had a secretary who came with me from Wharton, Sharon Brandt. Unfortunately, her husband was in the Navy and had to move to another city, and she had to leave. (After that I have had two great assistants during the past 15 years—Becky Leonard, followed by Jean Drake. As any leader knows, you can’t function without a top assistant.) I had a Wharton student, James Membrino, working for me as an intern and when he graduated he joined us full time. He was very good. We hired Wharton students part time to help us analyze companies we were thinking about acquiring. One thing I remember about most of the graduate students is that they were on the phone looking for jobs for a significant amount of time. After we started acquiring, my son Steve, an attorney, came up from Washington two days a week to help us.

The Professional Schools Business

In 1993, my son Brad, who was also in the entrepreneurial business, uncovered an opportunity with Career Com, a public company in Pennsylvania that had gone bankrupt. The company had operated several schools, including six that deserved to remain open because they were the best of the bunch and had the potential to survive. The business had been horribly mismanaged, and as we went into bankruptcy court to go through the process of acquiring these schools, I realized again how poor leadership leads to a business being mishandled from a shareholder perspective. Before declaring bankruptcy, the company had had about $100 million in annual revenues, though the part we acquired was just a portion of that. Its headquarters was a big castle outside Harrisburg with a lounge downstairs where people went and drank after work. It had an airplane and all kinds of cars, and there were other questionable activities going on at the company. Their IT department had budget of $8 million and 22 people. The business side was totally out of sync with excessive expenses that were not supported by revenues. We decided to buy only the six schools. I would say the odds of those schools surviving were about 20%; but the price was right and we were risk takers.

The schools had every problem that such institutions could possibly have. Faculty members were leaving. Student enrollments were dropping because no one knew how long the schools would remain open. Advertising, which could have helped recruit new students, had stopped. Accreditation agencies were about to withdraw their accreditation. For schools like these, which were two-year degree-granting colleges for computer programmers, nurses, health-care providers, and so on, this perfect storm of problems was almost the kiss of death.

Part of the reason several private schools got into this situation was that during the 1980s, a variety of people who had been in the S&L business and other lines of work unrelated to education got into this field. When they saw that they could get government funding for students whom they recruited for their schools, this tempted them to introduce highly questionable practices. Some of these were big, publicly held companies, but even they were misusing the system. Some of them would get people out of unemployment or soup kitchen lines and enroll them in schools, supposedly to help them reenter the workforce. These so-called students would often not show up to attend a single class, but the schools would get the tuition from the government. As soon as the Department of Education realized what was going on, it came down with a hammer on such for-profit schools. And when they went belly up, no one wanted to buy these schools because their problems were so deep-rooted.

My colleague Gerard Francois, who had worked for Coopers & Lybrand and now is a principal of The Palmer Group, has been involved with analyzing career schools for a long time. He describes the schools that got into trouble this way: “Their senior executives had a lapse of judgment. In any company, in order to continue to succeed, you need to constantly improve your product, people, and marketing. Instead, these executives bought jets, and their shareholders paid the price because the company’s surpluses were used for wrong purposes. They got greedy.” Little wonder that most people saw such career schools as a terrible investment.

I had a different view. The more I looked at this business, the more I thought it was critical for the future of the American economy. If you look at how many people graduate from four-year colleges, that number is somewhat higher than 30%. The U.S. is the best in the world in relation to four-year institutions. But what about the other 60-plus percent? We are among the worst in the world. In the U.S., if you go on to college, that’s your path to success. If you don’t go on to college, no one seems to worry about you. In Philadelphia probably 50% of its working population is technically obsolete in today’s world. The jobs they used to do have gone to Taiwan, Hong Kong, China, Mexico, or wherever. Those jobs just no longer exist here. People often ask, “Why can’t we get jobs?”—but in my view, the question isn’t so much why jobs aren’t available, but why we aren’t training people to do the jobs that are available.

It appeared to me that if we got into this business, it would fit my criterion of doing something meaningful and worthwhile—so we went ahead with the acquisition of the six schools, creating a company we named American Education Centers. When I met and spoke with the students, it helped me understand the impact our activities had. One time, I remember going to Atlanta to give the graduation speech at one of the schools. I met the president of the student government and asked her, “How did you come to be here?” She told me that after 15 to 20 years of marriage, her husband had left her. Before that, she had never held a job—but after her husband left, she had to provide for two children without having any professional skills. Initially she got a clerical job that paid $12,000 a year, and she took it despite knowing that she couldn’t give her children the things they needed on that kind of salary. Meanwhile, she also enrolled at our school to become a legal stenographer. “And I will become one, after I graduate in three months,” she said. I asked her how much she would make as a legal stenographer, and she replied, “If I were to go into Atlanta and take a job with a firm there, I would make more than $40,000. But I need to spend more time with my children, so I’ve already contracted with two local law firms—and I will make between $30,000 and $35,000 a year working for them.” In other words, by learning the skills she needed at our school, she would double and possibly triple her compensation.

As I met more students, I realized that her story was typical. Our students would take advanced software courses and go out and start making $60,000. We trained nurses who would go out and earn $35,000 to $40,000. We had TV and radio technicians who went on to make $50,000. Our schools were able to take people who had a high-school degree and who might have been flipping burgers at McDonald’s or Wendy’s, and in two years, on a part-time basis, we could put them into a career where they could go out and double or triple their incomes. Two-thirds to three-quarters of the students were women. Almost all of them had children and full-time jobs. The majority were single parents. I looked at this situation and thought, “We are doing a great thing.” We had hit a niche here about which I felt really good. As our operations developed, over time we came to acquire more schools. In all, we acquired 20 entities and never had one fail—which is unusual for an organization like ours.

At the time when we started buying schools, no one would lend us money because of all the questionable practices that were rife in this industry. We needed additional capital so I took on a partner who owned 45% of this business. My partner was Jim Walter, who had sold his home-building business, Jim Walter Corp., to the LBO experts Kohlberg Kravis Roberts in 1987 in a deal worth more than $3.3 billion. He had made a lot of money. Jim was an old-fashioned businessman, and he was the kind of person with whom I like to do business. When I went to see him—I knew him very well—I told him, “Jim, I am going into this business, and I would like you to be my partner.” He said fine. I told him I did not know when we would be buying schools, but when we did, I would put in 55% and he would put in 45%; and apart from seller debt, we would not have to borrow any cash. He said that’s fine. I asked what kind of arrangement we should come up with—and Jim said, “You just write it up, and it will be fine with me.”

I sent Jim the shareholder agreement and called to ask if he had read it, and he said, “Absolutely not.” His philosophy was to invest based on people...and he was a very smart investor. Jim made his investments based on people he knew, trusted, and respected. As a result, he did not have to worry about all the things that investors worry about today. He told me, “I know you’re going to be fair. Nobody can put together a contract that is as good as two honest people working together.”

This illustrates the importance of choosing the right people to do business with. I always bent over backward to resolve any ambiguities in Jim’s favor, and he trusted me. That is why he was my partner until he passed away in January 2000. I bought back most of his interest that had been passed on to his children—except that he had told his wife that she should never sell her portion of this investment. He told her before he died that this was one investment to which she should hold on until we exited. She made a lot of money by taking Jim’s advice. I learned a lot in this business about people. The faculty members at Wharton are good people. There may be a couple of bad apples, but by and large they are good folks. The same thing was true of the partners at Touche Ross—they also were good people. In the business world, you meet all sorts. The most important thing is to deal with people whom you can trust and who are honest. Therefore, if you ever plan to go into any kind of entrepreneurial venture, the most important thing to remember is that you must have two honest people doing business. The worst experiences I had in my 15-year career as an entrepreneur/investor occurred when I deviated from this rule and got involved with people who were not that way. Later I’ll describe these painful experiences.

In addition to a financial partner, I needed an operational person who could run the business. After the first person we hired was not up to the job, I brought in a second person, and he was terrific in turning the schools around.

The person we hired to become the CEO of AEC was Bill Brooks. He had earlier run Spartan Aeronautics, a school that educated people who wanted to learn how to fly aircraft. He had dramatically improved the productivity of the business, which had gone from graduating 130 flight students to graduating 750 to 760 flight students, by doing simple but innovative things such as doing maintenance at midnight (so that the aircraft were not grounded for maintenance when the students needed to fly them). I was hoping that Brooks would be able to bring about a similar transformation at the career schools we were acquiring—and he succeeded in doing just that. Let me add a third point to the inviolate rules of adequate due diligence and doing business with people you respect and trust. Take whatever time is necessary and, within reason, spend whatever is required to get the right CEO—it’s hard (if not impossible) to succeed without having the right person leading the ship.

Our experience in turning the schools around taught us a great deal about leadership in an entrepreneurial context. What did we have to do? Everything. We had to hire almost all new administrative people. Some of the faculty remained, but we had to replace a substantial number. We put in new systems. We put in an online system that told us everything about our business—how many people applied for the courses; where that application was in the process; where we got those applicants; all our financial data, our bad debts data, and everything we needed to know. All this was available to us online and in real time. It was probably the most sophisticated management information system that any private group in our industry had.

In addition, we had to physically change essentially every facility. For example, in Cincinnati, Ohio, the school was in an old electric company building that was falling down. We had to move to a new building in a different part of town. We had to reestablish relations with all the regulators and put in new procedures. We had to get rid of many of the admissions people because they were using questionable practices and that is one of the things that got the schools into trouble. We put in new computer laboratories that were so state-of-the-art even larger institutions could not match them. They seemed like space-age facilities. We had to change everything from top to bottom—and we did it as though we were going to own these companies forever.

Initially when we started acquiring the schools in 1993, they were cheap because we bought them out of bankruptcy. As we went through the 1990s, however, the proprietary school industry came back in vogue and we were competing against everybody else. After the first purchases, we did not buy any more out of bankruptcy. There are only 3,000 proprietary schools in the U.S. We had a list of all of them. We sent them letters, we went and visited them, and when we found a school that looked like it would fit with our portfolio, we bought it. As prices went up, we started working with T L Ventures, a venture fund headed by Bob Keith. They provided funds for a minority position in some of our investments and gave us full operating control. They have been great partners.

We kept some key issues in mind while targeting schools for acquisition. We wanted schools that were compatible with the kind of training we did. Geographically we focused on the Midwest. Someone once asked me, “Why do you like this region so much?” I said, “Because I understand those people.” The Midwest was a good region for us to concentrate on because it had a lot of people who needed the kind of retraining we offered. They generally had favorable state rules for proprietary schools. Typically, we would look for a mom-and-pop operation, where they were getting ready to retire or just getting tired of the school business, because it is a difficult business. It is as bad as the restaurant business, because you have to be there all the time. You have to make your admissions work. There are lots of federal regulations. We looked for somebody who wanted to sell out in a good location. Typically they would not be doing well, though they would not necessarily be losing money.

We would take that situation and triple the enrollments. We could go into a school that had been operating for 20 years and through installing new leadership and modern techniques—advertising, admissions, and other systems—we could dramatically build up their enrollments. One school that we bought, in Fort Wayne, Indiana, had 77 students when we bought it and we were able to increase the number to 750 in a relatively short period. We had the ability to do that—giving people a very good education and a very high placement rate when they left. So we kept buying schools. That is how we built the business.

We tripled enrollments also by doing innovative things. Let me give two examples. First, most proprietary schools start, just as most colleges do, two or three times a year. If a student decides to go to school, he or she might have to wait three or four months to start. Well, students who want to go to a professional school don’t want to wait that long. Once they have decided to go to school, they want to get going. So we started sessions 12 times a year. To my knowledge, no one else was doing that at the time. The faculty members didn’t like it very well because it disrupted their class schedules. And we had to configure the curriculum in a way that allowed for a very different way of doing things. But it accommodated the students who wanted to get started right away.

Second, we introduced what we called a 50-50 program. If you are a working mother or a single parent with children at home, your biggest problem in going to school will be finding the time to go there two or three times a week. To deal with this issue, we split each course into two parts: what you would do in the classroom and what you would do online. We gave each student a computer so that they could log on from their work or from the office. By doing that, we cut in half the time the students had to be in our facility. This approach gave them a lot more flexibility, but it still gave them a classroom experience, which they needed. We couldn’t teach these courses exclusively online.

Meanwhile, what the 50-50 approach did for us internally was to double our capacity. If you can have twice as many students as you used to have because they are only in a classroom one-half as much of the time, then that is a big thing. It went a long way in helping us reach double or triple the enrollments at each school.

The financial performance of the schools improved dramatically. As Brooks, our CEO, recalls, when he came to work for us, “we were on track to lose $700,000. We made a complete change, and we ended up losing $300,000. The next year we made $250,000.”

One other important change we made was to meet the demands of the job market. Traditionally, what many proprietary schools have done is to focus on just one area of instructions, such as computer software or travel. The problem with that approach is that if the technology sector goes through a bust (which it did) or the bottom falls out of the travel agency business (which did happen), it drags the schools down as well. We decided to look at what the market was asking for, and to focus on those courses. As a result, while a lot of schools still had travel courses at a time when the airlines were slashing payments to travel agents and travel agencies were going out of business, we got rid of all our travel courses. We got rid of all the court reporter transcription courses. We were one of the highest in the U.S. in terms of people passing that test, 14%. The national average was 9%. Would you want to be training people in an area where only 14% of the people got jobs? We got out of that. We asked, “What does the market want?” If the market wanted health-care people, we should shift right into the new area. We might not cut down on other areas completely, but we would change our emphasis.

Gerard Francois, my partner, says that our ability to offer different kinds of programs protected us against the risk of demand for certain types of courses drying up unexpectedly. “We had three key programs: IT, business, and health,” he says. “When the IT bubble burst in the spring of 2001, demand for those courses declined but demand for health-care courses went up.” These strategies allowed us to keep growing.

Exit Strategy

We did this for a decade. As word spread about our activities, a lot of people tried to buy us out. We were probably as good a privately held proprietary schools group as there was in the U.S. While we were not the biggest, we were certainly among the biggest—our annual revenues had grown to around $50 million to $60 million. When people asked if we were interested in selling, we said no.

Eventually some folks from Education Management Corp., which I consider the country’s best publicly held proprietary school group, approached us. The founder, Bob Knutson, and its CEO, Jock McKernan, the former governor of Maine, came to our office. Their approach to us was simple: They said, “We know you don’t want to sell, but some day you will want to exit from your investment. What would it take for you to consider selling now?” We had essentially no debt, and we had paid back all the investment we had put in plus some. I said that for us to consider a sale, it would have to be an offer of more than $100 million in cash, and you would have to hire every one of our people. They said, “Okay, we’ll do it.” Ultimately we sold the school business for essentially $120 million in cash. That was a big win. EDMC lived up to every one of the things they told us they would do, including hiring all of our people. Bill Brooks, our CEO, eventually became the chief operating officer for all of Education Management.

After the sale of our proprietary schools business to EDMC, we acquired another education business in San Francisco, called Fire Solutions. This company, which was established in 1998, provides online training to brokers and others who have to be licensed or have to take exams to move up in the world in insurance, brokerage, and other industries.

Our most recent acquisition in The Palmer Group tested our resolve to exercise great care in selecting each new purchase. It is Salem International University, a university in Salem, West Virginia. It has about 700 students on campus and a few hundred online. It is a school that has a rich background, with several well-known people going there including a prominent senator and a former governor. As with many primarily liberal arts colleges, it started to fall on hard times more than 10 years ago. Some foreign investors came in and, in effect, controlled this nonprofit school by buying the land and buildings and putting some of their representatives on the board of trustees. A Japanese group owned the school for several years and then sold it to another group in Singapore. Between the two groups, they invested upward of $30 million over the 10-year period.

When we looked at this situation, it was bleeding cash to the tune of about $500,000 to $600,000 a month and was within a few weeks of bankruptcy. This was the most difficult acquisition we ever made. We had very little time to look at the situation since they were going to be forced into bankruptcy in the very near future. They needed cash immediately and they had every problem you can imagine. They had problems with the accrediting agencies, problems with the federal and state governments, problems with their creditors, and on and on and on.

The school, however, presented a group of very attractive opportunities. We are now in an era when more and more education is going to be provided online. Salem International University had accreditation with the regional accrediting body, which is the highest accreditation you can get; it had an online system; and it had graduate programs including a masters in business administration and a masters in education. This is a very powerful foundation in today’s education world. In addition, we were fairly confident that the Department of Education was going to drop the requirement of having 50% in class attendance in online programs, which they did later, and this would make the situation here even more valuable.

We did as much due diligence as we could in the time we had. We saw that this was a high-risk, high-reward situation and decided to involve a venture capital fund that would lower our risk. We put in capital before we closed, getting the land and buildings as collateral. We then continued our due diligence while having to put in additional capital and concluded the deal essentially within 60 days. There were other potential buyers involved but they just couldn’t move that fast. When we got through with our due diligence, we went to the foreign ownership and gave them an extremely lengthy list of everything we found and told them that we would give them only $500,000 for the land and buildings and they would have to forgive about $7 million in debt from the university. It seemed like a relatively low price to pay for 28 buildings, 500 acres, and an operating school to boot. We got an estimate on the replacement cost on the buildings and that alone was $78 million. But these buildings were worth nothing if you didn’t have a functioning school, and the $500,000 was just the tip of the iceberg relative to the money we were going to have to put in. We immediately had to infuse $5 million to keep the operation going.

We then went about what we had learned to do fairly well. We got a CEO who had been through school turnarounds on several occasions and asked if he would take this on for a two-year period until we got our permanent CEO. We turned the not-for-profit school into a for-profit entity, and that required us to apply through the state. West Virginia is a very good place to do business and it went smoothly. We talked to the Department of Education, other federal agencies, the accrediting agencies, the creditors, the state education agency, and many others and were able to buy some time.

Then we went about cutting costs. We cut out some non-essential employees, although this had already been done to a considerable degree and we didn’t have much room here. We dropped all the watersport programs, and we got rid of an equestrian program that was costing a couple of hundred thousand dollars a year and put the equestrian center itself up for sale. We donated some land and historic buildings to a local foundation and took a big tax deduction. We brought in some new faculty and all new key officers working for the CEO. In 24 months we were approaching a break-even point. The previous owners had put $30 million into this operation and all they had to show for it financially was that it was continuing to drain $500,000 to $600,000 a month in cash.

We are now on our way to building our online operation. We hope to have 6,000 to 10,000 students in these programs within five years, and we will have a very valuable enterprise. We are going to operate this school as though we are going to own it forever. We are going to upgrade the quality throughout the institution and we are going to be very proud of what we do. In the process we are going to do good things for a lot of students and West Virginia. We are the biggest employer in Salem, and we are going to be good community citizens and help provide economic impact to this very depressed region. And we are going to feel good about what we do and have a lot of fun along the way.

This is how it goes in entrepreneurial leadership if you know what you are doing. By the time we got to buying professional schools, we had learned some very hard lessons from ventures that didn’t go all that well—at least in the beginning. In effect, we learned about the pitfalls firsthand.

When Entrepreneurial Leadership Fails: Errors and Potential Pitfalls

Probably the most dangerous pitfall confronting a would-be entrepreneur is inexperience. Whether the potential entrepreneur has an idea for a service or product to commercialize, or feels the urge to become an entrepreneur without a specific plan for how to proceed, there is a good chance that he or she lacks experience in pioneering new ventures. This was certainly the case with me and my partners when we began the Palmer Group. Our mistakes were a textbook lesson in what to avoid.

The first company we bought was Spike’s Trophies in Philadelphia. It was the city’s oldest trophy, plaque, and business-gift manufacturer, with sales of a couple of million dollars. This investment was a negative learning experience—in part because we failed to do proper due diligence. I overpaid for the company because it turned out that our due diligence wasn’t effective enough to spot some adjustments that should have been made to the financial statements. I had borrowed money from Mellon Bank to buy the company, and when these facts emerged we almost immediately went into default.

That was when I had my first real personal experience with bankers. Mellon Bank was going through a difficult period and was trying to clean up its loan portfolio. I told the bankers, “What are you worried about? I am going to pay you.” They said, in that case, please put your personal signature on this loan (I was not personally liable). I said, “I don’t want to put my personal signature on the loan, because you have my word. You are going to get paid.” Mellon Bank said it would rather have us pay 60% right away to close out the loan rather than the whole amount later. Reluctantly, I agreed—even though I did not want to do it that way. Eventually the problems were resolved and we kept the company for 12 or 13 years before selling it to the employees. They were overjoyed.

The experience with Spike’s Trophies taught me that I didn’t know enough about buying companies, and that I had to be more careful next time. Although I had been entrepreneurial at Wharton and also at Touche Ross, I had not been an entrepreneur in the buying business sense. But the school of hard knocks had more lessons in store for me.

We then went into the payroll business. I went to a friend who had been successful in that business and told him I wanted to go into the same business. He said, “I know two great people who used to work for me, and they could help you out.” At that point I made a basic mistake: I didn’t check them out with anyone else. I thought that if these people had been working for him for 10 years, they must be good. I should have known better.

We carefully drew up a contract that described the way we would be involved and defined their role as the day-to-day operators. It soon became clear to me, though, that in their mind, we were only one thing—a source of capital. We owned 85% of the company, and they wanted more capital as we went along. Their argument was that the more capital that was available to get new accounts, the bigger the payroll business would be. They were not willing to listen to our views about the way the business should be run, especially about controlling expenses and growing profits. They just wanted to keep getting money from us so that they could build the operation faster and faster. Eventually we faced an impasse. The president kept telling me that he was going to quit because we did not do the things he wanted us to do, and when my patience was exhausted, I said, “Fine, you just did.” He couldn’t believe I said that. I did not have to fire him—he threatened to quit, and I accepted.

Then I went through a dismal period where they tried to force me to sell out to them. They sued, arguing that I was trying to force them out, and it went to arbitration. This was a little company with a couple of million dollars in sales, and the fees from arbitration were several hundred thousand dollars. It was a nightmare that went on and on for more than a year. Eventually we sold the company.

These painful experiences happened because I went into business with people I shouldn’t have. The lesson is that we didn’t do enough homework on the people we were dealing with. We should have looked more closely to understand what their motivations were for entering into this deal with us. This would have helped us to determine what their goals were, what they had done previously in other difficult situations, and they interacted with their customers, vendor, and other partners in the past. In other words, we needed to be sure their goals would be aligned with ours.

These and several other experiences were the pitfalls I encountered. I took away from them three lessons on how to avoid them. The first is that as a part of any due diligence that you do, be sure that you check the references of anyone with whom you are going to do business. Check with not just the people they give as references but also the others whom you find yourself who might be able to give you an unbiased opinion. That is much more important than how glib someone sounds in an interview.

The second lesson, if you are buying an existing business that you intend to run, is to make certain that the financial figures you are furnished are accurate and factual.

The third lesson concerns the arrangements you may have with partners in the venture. If you set up a partnership—even with people you believe to be very honorable—you are inviting trouble if you set it up as a 50-50 venture, or one in which the management thinks you are a silent partner, or one in which they control the management of customer relations in the enterprise even if you own 85% of the stock. Somebody needs to be the leader and have a shareholder’s agreement that clearly states where the control vests. If you have a partner, you may not always see eye-to-eye on every issue, and sooner or later, someone will need to make a decision. If there are two equal partners, sooner or later you generally have problems. The payroll company was probably the worst experience I had in 15 years as an entrepreneur. It was my own fault and I take responsibility for it.

There are other pitfalls that we did not encounter, but that other entrepreneurs have encountered, that need to be mentioned. Tom Presby, whom I have known since our days together at Touche Ross, works closely with CEOs of entrepreneurial companies. This has made him a shrewd observer of errors that entrepreneurial leaders make. According to him, “The first mistake entrepreneurs make is not making money. They should understand that loss forecasts are always achieved and often exceeded. The biggest failure I see among entrepreneurial leaders is that they are willing to defer achieving profitability. There is no such thing as an excellent organization that is unprofitable.”

Another common error, he says, is not raising enough money. “I meet with entrepreneurs all the time, and they don’t know what they need,” he says. “They are too focused on one aspect of their operation to the exclusion of others, and then other things wither. To succeed as an entrepreneurial leader, you need breadth of thought. You have to be a people person to build an organization that focuses on every important activity, not just the one the CEO thinks is most important.”

This leads me to my final point about entrepreneurs: If they are successful, they will find themselves leading in a different context.

Leading in Another Context

Successful entrepreneurs find that as the business grows, so does the organization. What worked for them in the early days will probably not work when they are responsible for a growing and increasingly complex business. Tom Presby, who just told us about certain pitfalls, points out that the best entrepreneurial leaders recognize that they need to evolve. “I know CEOs who started out not being too involved in finance, but now because of Sarbanes-Oxley are involved in finance at tremendous levels of detail,” Presby says. “At another company, the CEO is very entrepreneurial but not systematic enough. All this shows that leadership is not a static activity. Leaders have to change and develop new skills and interests. They might have to do things they find repugnant so that they can keep building their organizations and themselves.”

Leadership and Social Entrepreneurship

Bill Gates caused a stir in the summer of 2006 when he announced he would gradually give up his responsibilities at Microsoft to work much more actively with the Bill and Melinda Gates Foundation. This foundation focuses on global poverty and hunger, global health, and education, especially inequalities in the U.S. educational system The significance of that pronouncement increased further when Warren Buffett, who knows Gates well, said he would donate $31 billion in the form of 10 million shares of Berkshire Hathaway stock to the Gates Foundation, bringing its assets to more than $60 billion.

In recent years, entrepreneurs from George Soros to Nobel Laureate Mohammed Yunus have chosen to focus on social problems—although they may lack the resources of Gates or Buffett. As a result, entrepreneurial leadership in the nonprofit sector has become vitally important—and before ending this chapter, I would like to address this unique context and the special challenges such leaders face.

These leaders’ goal is often to prove to themselves as well as their constituents that in addition to building a profitable company, they can also make a difference to society. In a few cases, the not-for-profit enterprise takes on a momentum of its own and makes as dramatic a contribution to society as the leader’s for-profit activities. For this process to work, the leader must be able to translate his or her business leadership skills effectively to the nonprofit world.

John DiIulio, an expert in Jesuit leadership and a highly respected professor at the University of Pennsylvania, says he often talks to business leaders who want to become philanthropists. “I tell them not to leave their skills in the corporate office,” he says. “The principles of leadership are the same, though the context is different.”

Bill Gates is a good example of a leader who has applied his business acumen to the nonprofit context. “Gates found people who knew what he wanted to achieve—and focused on achieving measurable outcomes,” DiIulio says. Another instance is that of William E. Simon, the former secretary of the U.S. Treasury during the Nixon administration. With his son Bill, Simon played a role in the development of PAX TV network, says DiIulio. “They asked if there was a market for a television network that aired programs with no sex and violence,” he says. “They conducted surveys and approached it as any social scientist would. They approached it analytically—and they found that there were people who strongly believed in the value of wholesome television. They did not lose their sense of analyzing market demand before plunging in.”

According to DiIulio, an important difference between leadership in the corporate and nonprofit worlds is that “in the nonprofit world, there is no bottom line. You have to have measurable impact, but in the nonprofit world, just as in government, how things get done is as important as what gets accomplished. This emphasis on process is very important.” Leaders from the corporate world need to understand that difference in context.

One of the most important changes in nonprofit organizations in recent years has been the infusion of corporate leadership principles, DiIulio notes. “The attention to measurable results and high-yield philanthropy has been the result of corporate principles being applied in the nonprofit context,” he says. “In the nonprofit world, the focus is on getting the boulder to the top of the hill. When people look for advice on leadership, they look to corporate leaders. You may be operating in the context of a nonprofit, but in the end, you need the discipline of being able to say whether you’ve got the boulder up the hill or not. You may take the context into account, but you’ve also got to take the boulder up the hill.”

Virginia Clark, who worked for the University of Pennsylvania before moving to Washington, D.C., as head of fundraising for the Smithsonian Institution, explains that the world of nonprofits is similar as well as dissimilar to academia. She says, “In academia, you have faculty who do research, some who teach, others who provide services to students—and an infrastructure of staff to support them. At the Smithsonian, we have some researchers, others who deal with the public, and an infrastructure to support them. In some ways, this makes them similar.”

At the same time, Clark says, “there also are ways in which academic institutions and nonprofits like the Smithsonian are not similar. In academia, a certain number of students come in every year, they pay tuition, and then they graduate and become alumni. That gives some predictability to the institution’s cash flow. At the Smithsonian and other nonprofit institutions, the public comes in all the time. Nonprofits don’t have the predictable cash flow that you have in academia. Some museums depend on blockbuster exhibits to raise revenues, but they are far more vulnerable to factors like the weather than academic institutions.”

These similarities and differences have major implications for leadership. “Because cash flow is so unpredictable, you have to be rigorous in long-range planning for the future in nonprofit organizations,” says Clark. “In academia, you can get caught up in short-term thinking, but in a nonprofit you have to be disciplined and keep your long-term goals in mind.” Another implication, according to Clark, is that nonprofit organizations need leaders with greater strength of character and personality than might be essential in academia. “The reason is that you don’t have a strong safety net or infrastructure around you in a nonprofit,” Clark says.

Leadership at the Smithsonian has its own challenges. “The Congress gives us a fair amount of money but we don’t belong in anyone’s constituency,” Clark explains. “If we were in Chicago, for example, we could marshal the resources of the Congress representatives from Illinois, but we are in Washington, D.C., and the mall, so we are everybody’s. To deal with this situation, we have to make our case correctly so that we can argue things from a purely financial view. We have to be able to make a nonemotional, financial case for our needs.”

Clark says that she also ensures that “our board of directors and best donors know that case, so that they can bring it up with the Senators and Congress representatives in their constituencies. We have to position ourselves as ‘America’s museums’ and make it an emotional appeal.”

In sum, Clark notes that leading in the context of nonprofits has unique challenges: “Leadership in dealing with the uncertainty involves making a strong financial case, aligning our constituents behind the case, and also an emotional appeal. Other nonprofits would have to follow a similar process. Whether you are an art museum in Chattanooga, Tennessee, or the Smithsonian, you would need to follow these same steps. It’s applicable to most nonprofits.”

Summary

• If you are acquiring a business, do your homework—your due diligence. You are never going to know as much as you should know, but you need to know as much as you can in the period you have until you make your decision.

• Deal with the right partners. If you deal with good people, your chances are infinitely better of having a happy, productive, rewarding outcome in the end. If you deal with the wrong people, the odds are heavily stacked against you and in any case it is going to be a miserable journey.

• If you are not going to operate the endeavor yourself, spend the time necessary to find a top CEO. After the decision of buying an enterprise or not, this is the most important decision you are going to make. I view myself as a good judge of people, but I am right only about half the time. This doesn’t mean that half the time when I am wrong the people I’ve hired have turned out to be disasters; they have just not been as good as they needed to be for the position. Some people who make an incredible impression are really only about an inch deep.

• Once you have made a tentative decision about who to hire, you need to do in-depth reference checks. It should be exhaustive, and not just with the people whom you are given as references. You know what they are going to say.

• If you have found the CEO and the leadership team, let them do their job. If the CEO can’t run the business by your standards, you have to get a new CEO. Good CEOs don’t want to be in an environment where they get their orders over the phone from some investor every morning.

• Don’t forget that you are the owner so you better stay close to what is going on. This requires very effective communication and an ability to know about problems very fast.

• Don’t go into 50-50 partnerships even with good people. One person has to be in control.

• At some point you have to decide whether you are going to go ahead with a particular venture. You can only study it so much. I know of one venture capitalist who never made a deal. He just kept kicking the tires until he found something that bothered him, and then he walked away. Maybe you can’t really call him a venture capitalist.

• Risk is tied to potential return. That’s what they teach you at Wharton and it’s true. I know of very few deals that have terrific potential returns with no risk attached, so in most cases you are going to take on the amount of risk that is commensurate with the potential return. So consider that carefully into your decision. On the other hand, I doubt if you want your portfolio to be one very high-risk singular situation that has tremendous potential but puts all your eggs in one basket. You may need several ventures to spread the risk.

• Treat your investments as if you were going to own them forever. You should run them as if they were a company in which you have pride and want to promote excellence in what it does, and reflect your character and the way you do business.

• The business sooner or later has to come down to profits, so make it sooner.

• Develop your leadership skills as your business grows and becomes more complex.

• Some operators think that investors are just an endless source of capital. That is not a healthy mindset. They should be turning a profit as early as possible. Profits should be used to fund new ventures and products, and if more investment is needed, this should be done very deliberately. Investors need to buy in on the need for infusing more capital. Capital infusion to cover operating losses over an extended period is bad.

• Communicate your thoughts clearly. In academia or nonprofit environments you may often use subtlety and diplomacy in your approach. Here you need to be straightforward and very clear relative to your position. If you don’t, it can cost you money or a deal.